AFA presidential address and investment manager competition

Robert Stambaugh's AFA presidential address focuses on "Investment Noise and Trends" He argues that the fall of equity ownership by individuals has had an important impact on the returns of institutional money managers.  Individual stock ownership has fallen from about 48 percent to levels hovering over 20 percent. The individuals have traditionally been the noise traders in equities. They are the ones that may follow trends, not follow fundamentals and be subject to behavioral biases. These are the people who were actively trading, but in the view of some would have been better not to trade. They did not make the markets efficient. The fall in ownership by individuals has been matched by increases in index and passive investing.

The active institutional managers were the ones that corrected the mispricing from these noise traders. If there are less noise traders, there will be less mispricing. The result is that active managers will not have opporuntities to make money from these individuals, the noise traders. The profits from active traders or the alpha that can be generated will fall as the same or more money will be chasing after fewer or smaller opportunities. The result will mean that active managers will not be able to generate above average returns which is what we have seen. The passive benchmarks have done better because there are just less opportunities for those who are active. Active traders need noise traders.

The result of falling noise trsders will be a decline in active management. Lower fees for active management. Less active bets. A move to passive management. The money management industry is in upheaval with the decline in noise trading and being smart may not be enough to survive. You have to be smart relative to your competitive peers. Active managers must accept sharper pricing and a premium on asset gathering. The small active manager will have to provide something special.